After Standard and Poor’s downgrading of the American credit rating, concerns around the globe and in capital markets went into nervous tension. The Euro’s crisis fueled those markets and investors are now asking how to manage their portfolios.
Investors want a safe quay to harbor their investments and securities. It has been said that the maximization of shareholder wealth is the main goal of a company. Executives and boards of corporate governance are always motivated to increase their shareholder gains.
But how can shareholders evaluate a corporation’s performance in times of recession? How will they analyze what is profitable, what is risky and what is safe? I have one main preference to perform the task: it’s the cash flow analysis.
Years ago, I was attending a University of Toronto session for a week called “Beautiful Minds” and I had the opportunity to listen a speech performed by Professor William F. Sharpe. He emphasized the importance to avoid risk, investment requirements for cash flow generation, and the significance of the net present value of cash flows.
To reinforce those concepts I went to my corporate finance books to find a useful poem that I recommend to all investors. The verse is a parody of The Raven, by Edgar Allan Poe, written by Herbert S. Bailey Junior, called Quoth the Banker “Watch Cash Flow”. I took Professor Sharpe and Bailey’s advice and I recommend it to investors, executives, and ordinary people interested in managing finance.
Finance management is presented to us in every moment. Everything that we do in our lives is surrounded by cash flow. The task of running a household needs to be planned in terms of cash, in the same way that a corporations’ transactions need to plan their cash flow.
People and corporations can generate gains, but this does not mean that they are generating cash. I have been observing companies for many years that are considered profitable; where they buy services and raw materials to be paid in thirty days or less, and then sell their services and products to be paid in sixty days or more. Because they present profit, analysts can call those companies profitable. I don’t think they are. They are risky investments because of their lack of liquidity. The same idea can be transferred to a household.
Companies working with high financial leverage are confronted with set up difficulties between cash inflow versus cash outflow. Those companies rely too much on obtaining financial resources from third parties. In recession times, cashing companies is not an easy task and the costs associated to achieve funds to finance operations are expensive. Analysts need to evaluate the planned cash flow for the long run. In the same way, investors and executives are required to pay attention to the cash flow statement, as it is an important tool to evaluate the company’s ability to generate cash to attend to the needs of the operation.
Analysts, households, investors, executives, boards of governance, pay attention to the cash flow. Analyze corporations’ cash flow statements and evaluate corporations’ planned cash flow for the long run. These are valuable sources to help drive your decisions.